Michael Watkins
August 04, 2023
Weekly Market Update
A bit more volatility added back into the market this week with the surprise rating change for the United States. Here in Canada, the manufacturing sector shrank for a third consecutive month in July. So far, 2023 has proven to be a relatively tough year for Canada’s manufacturing sector, one of the critical components of economic health. The decline in manufacturing activity might be signalling weaker economic conditions to come in Canada.
- Canada’s manufacturing sector contracted in July but at a slower pace than in June. The S&P Global Canada Manufacturing Purchasing Managers Index rose to 49.6 in July from 48.8 in June. (A reading below 50 denotes a contraction.)
- July’s manufacturing sector activity marks the third straight contraction for Canada and the fourth in the past five months. Slower new orders, a drop in employment and rising costs hindered the sector.
- Canada was not alone in its soft manufacturing sector activity. Manufacturing sector activity in the U.S. contracted for a ninth straight month. In Europe, the manufacturing sector has fallen to its lowest level since 2020. China and Japan also reported poor manufacturing sector activity in July.
- The global manufacturing sector has struggled for traction in 2023, mainly due to a drop in new orders and output. Global demand has been relatively muted amid high inflation and surging borrowing costs, which has put pressure on households and businesses.
Weak manufacturing numbers worldwide have contributed to the slowdown in global economic growth this year. Recent data might be signaling more weakness in global economic conditions. But the struggles in the manufacturing sector could indicate a potentially changing landscape of consumer spending. As we emerge from the pandemic, most spending has been towards more experience- or service-type products rather than tangible goods. Still, demand for several types of products should remain healthy over the long term, making the stocks of many manufacturing companies quality investments.
Turning to the States, Fitch Ratings has downgraded long-term U.S. government debt. A couple of months ago, Fitch put U.S. debt under watch as the government haggled over the debt ceiling. The downgrade could create some uneasiness among investors, elevating concerns about the U.S. government’s fiscal outlook.
- Fitch Ratings has downgraded the U.S. long-term foreign-currency issuer default rating from AAA to AA+, and assigned a stable outlook. This is the first downgrade in U.S. government debt since 2011 when S&P Global downgraded U.S. government debt to AA+, where it remains today.
- Fitch cited several reasons for its downgrade. The ratings agency believes the fiscal situation in the U.S. is likely to weaken over the next few years given increased spending combined with tax cuts. Furthermore, the frequent standoffs on the U.S. debt ceiling in recent years have weakened confidence in the government’s fiscal management.
- The ratings agency expects the government’s deficit to rise to 6.3% of gross domestic product in 2023, up from 3.7% last year. While the deficit is growing, the economy is expected to weaken, potentially falling into a recession, in response to a slowdown in consumer and business spending, according to Fitch.
- As expected, lawmakers in Washington largely disagreed with the ratings downgrade. U.S. Treasury Secretary Janet Yellen largely dismissed the downgrade, referring to it as “arbitrary.” However, this is likely to become a topic of debate at the next Presidential election.
Global equity markets were weighed down on the news this week, while the change in yields on U.S. Treasury bonds was relatively mild, considering the downgrade. Speaking to Bloomberg, many economists and market strategists expect minimal impact on financial markets over the medium term. However, ratings downgrades often weigh on investor confidence.
Across the pond, Eurostat released flash estimates on two key economic variables this week. The preliminary estimates showed the European economy expanded in the second quarter of 2023, while inflation remained elevated in July, despite softening compared to the previous month. The results could point to more interest-rate increases by the European Central Bank (ECB).
- Gross domestic product in Europe expanded by 0.3% in the second quarter of 2023 over the previous quarter. Europe’s economy has returned to growth after a revised 0.0% reading in the first quarter and declining in the last quarter of 2022.
- Among Europe’s largest economies, Germany’s economy was relatively flat, while Spain and France posted expansions in the second quarter.
- The European economy benefited from better consumer spending. Still, spending was relatively flat as consumers grappled with high prices and rising borrowing costs.
- Data showed inflation softened slightly to 5.3% year-over-year in July, down from the 5.5% inflation rate in June. Core inflation pressures persisted in July, remaining at 5.5% year-over-year.
- Higher growth and still elevated inflation could have the ECB raising interest rates further at upcoming meetings. At its last meeting, the ECB indicated it would keep an open mind about its upcoming rate decision, with a rate increase or a pause on the table.
Despite the increase, there is still much uncertainty about the outlook for Europe’s economy. Manufacturing continues to contract, while services sector activity has slowed considerably in recent months. Growth in Europe has differed from that in Canada and the U.S., which recently posted moderate growth rates. Europe’s equity markets are heavily concentrated in more cyclical stocks. During down periods, volatility might be high. However, times of improving economic conditions could help boost European stock markets.
As always, give us a call if you have any questions, or if you’d like to get together for a portfolio review.
Source: CIBC Morning Market Brief